Swedroe: Pension Plans & Consultants

March 27, 2019

It seems logical to believe that if anyone could beat the market, it would be the pension plans of large U.S. companies.

  • Given the large sums they control, they have access to the best and brightest portfolio managers—managers most individuals don’t have access to because they cannot meet required minimums.
  • It’s not even remotely possible they ever hired a manager with a record of underperformance.
  • The vast majority of pension plans hire professional consultants to help them perform due diligence in interviewing, screening and ultimately selecting the very best. You can be sure these consultants have thought of every conceivable screen: management tenure, depth of staff, consistency of performance, performance in bear markets, consistency of implementation of strategy, turnover, costs and so on.
  • The fees they pay are much lower than fees individuals pay.

Pension Fund Performance Research

Despite these advantages, the research shows pension plans do not outperform appropriate risk-adjusted benchmarks. We’ll examine the findings from four studies.

The first is the 2007 study “The Performance of U.S. Pension Funds” by Rob Bauer, Rik Frehen, Hubert Lum and Roger Otten, which covered 716 defined benefit plans (1992-2004) and 238 defined contribution plans (1997-2004) and found:

  • Returns relative to benchmarks were close to zero.
  • There was no persistence in pension plan performance.
  • Fund size, degree of outsourcing and company stock holdings were not factors driving performance. This finding refutes the claim that large pension plans are handicapped by their size.

The authors concluded: “The striking similarities in performance patterns over time makes skill differences highly unlikely.”

The 2008 study “The Selection and Termination of Investment Management Firms by Plan Sponsors” by Amit Goyal and Sunil Wahal provides us with further evidence on the inability of plan sponsors to identify investment management firms that will outperform the market after they are hired.

The authors examined the selection and termination of investment management firms by plan sponsors. The database covered approximately 3,700 plan sponsors from 1994 to 2003. The following summarizes their findings:

  • Plan sponsors hire investment managers after those managers earn large positive excess returns up to three years prior to hiring.
  • Post-hiring excess returns are indistinguishable from zero.
  • If plan sponsors had stayed with the fired investment managers, their returns would have improved.

The bottom line: All the activity was counterproductive.

Additional Findings

The 2000 study “A Panel Study of U.S. Equity Pension Fund Manager Style Performance” found similar results. Authors T. Daniel Coggin and Charles Trzcinka studied the performance of 292 pension plans with 12 quarters of data up to the second quarter of 1993. The following summarizes their findings:

  • It is very difficult to find investment managers who consistently add value relative to appropriate benchmarks.
  • No correlation was found between relative performance in one period and future periods.
  • There was no evidence the number of managers beating their benchmarks was greater than pure chance.

Coggin and Trzcinka concluded: “Those relying on historical data on returns are likely to be disappointed.”
Tim Jenkinson, Howard Jones and Jose Vicente Martinez, authors of the 2013 study “Picking Winners? Investment Consultants’ Recommendations of Fund Managers,” examined the aggregate recommendations of consultants with a share of more than 90% of the U.S. consulting market. They found that the consultants’ recommendations of funds are driven largely by soft factors rather than the funds’ past performance. They also found that while their recommendations have a very significant effect on fund flows, there is no evidence that these recommendations add value to plan sponsors.           

Claims Vs. Performance

While investment consultants tout their ability to identify future outperformers, the evidence clearly suggests otherwise. This raises such important questions as:

  1. On what basis are the claims made?
  2. Why do pension plans hire consultants?

Gordon Cookson, Tim Jenkinson, Howard Jones and Jose Vicente Martinez contribute to the literature on the performance of investment consultants with their July 2018 study “Investment Consultants’ Claims About Their Own Performance: What Lies Beneath?”

Their analysis is based on a unique data set sourced by the U.K. regulator Financial Conduct Authority, which provides detailed records of the institutional asset managers recommended by three leading investment consultants between 2006 and 2015. Each of these consultants, which together have a worldwide market share of around 45%, also produces an analysis of its own recommending performance, to which they had access. The following is a summary of their findings.

First, they found that all three consultants claim that the products they recommend produce significant excess returns, ranging between 1.6% and 2.5%. Each uses a different methodology and does not make the underlying data available to the public. Thus, institutional investors must take on trust the basis for these claims as well as their comparability.

Second, despite the claims, Cookson, Jenkinson, Jones and Martinez found that, on average, consultant-recommended investment products perform no better than other products available to institutional investors.

In fact, they found that over their 10-year sample period, the portfolio of all products recommended by investment consultants delivered average returns gross of management fees that are 0.2% per annum lower than the average returns obtained by a matched sample of available products classified in the same investment category (such as U.S. large cap value). They found no evidence of outperformance in any of the three categories of equity, fixed income and other (balanced/multi-asset, alternatives/hedge funds, real estate). They also found “no consistent differences between recommended and non-recommended products in terms of return volatility or betas with respect to manager-chosen benchmarks.”

Among the causes of the gap between claims and results, the authors found, were “comparisons to benchmarks [which can be inappropriate] rather than to peers, inclusion of simulated and backfilled returns [which create well known biases], use of investment horizons that allow losers to be forgotten [survivorship bias], and unexplained exclusions of products from the analysis.”

The authors concluded: “Institutional investors cannot verify investment consultants’ claims, and may therefore be following consultants’ manager recommendations, and allocating assets, on false pretenses.”

Cookson, Jenkinson, Jones and Martinez also concluded: “We find significant differences between consultants’ claimed performance and our own calculations. Most, but not all, of those differences can be attributed to practices by consultants in their self-assessment which we have identified. A comparison between consultants based on their own claimed performance shows that there is no monotonicity between consultants’ claims and their actual performance, suggesting that consultants’ disclosures may not be good guides to their relative performance either.”


The bottom line is that, while consultants may add value in other ways, there is no evidence to suggest they add value in the selection of actively managed funds, which begs the question: Why do pension plans continue to use them for that purpose?

One explanation is they are shielding themselves from blame in case their chosen managers perform badly. Another, suggested by Cookson, Jenkinson, Jones and Martinez, is that, “The way in which consultants present their own ability to pick fund managers is so favorable that it becomes difficult for plan sponsors to ignore their recommendations.”

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.

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